Active and tracker funds both have pros and cons

Kieron Bassett.

Kieron Bassett

Published:08:00Thursday 28 May 2015

If you are investing your money there are two forms of investment you can make, active or passive.

Active management has a fund manager involved and there are currently over 2000 funds to choose from. These funds are run by managers who decide which companies to buy on your behalf and which companies to sell.

They aim to deliver a return that is superior to the average return in its chosen sector.

Also these managers can make tactical decisions to move money out of one area or sector if they think these are going to decline and potentially shield you from losses, whereas tracker funds aim simply to track a market.

A debate has raged for years about which is the best strategy with the focus of the debate being about charges. Passive or tracker funds tend to charge about 0.25 per cent per year to run their funds whereas active managers tend to charge 0.75 per cent per year.

This means that on average the actively managed funds have to outperform the passive by 0.5 per cent year on year if they are going to achieve overall better performance.

Given their cost advantage, do trackers outperform managed funds? Well with a tracker you do get certainty in that you can pretty much depend on the fund to give you the average return on the index but they are not going to perform above the average, and this is why most people invest in actively managed funds to hopefully achieve out performance.

Also they will just follow, for example, the FTSE100 index and as mentioned this can be very concentrated and therefore become very volatile. For example, at the time of the financial crisis when the banks collapsed they did make up a high proportion of the index, and the FTSE100 in particular suffered. Whereas active fund managers can take evasive action when this happens, so active funds tend to perform better in these markets.

As you can see active and tracker funds have benefits and drawbacks, but increasingly the choice for investors is not whether to opt for active or passive funds, but how to blend them to achieve the desired investment outcome.